What Is a Cost-Plus Model?

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Minimizing costs is critical to achieving profits with a cost-plus model.
Minimizing costs is critical to achieving profits with a cost-plus model. (Image: monkeybusinessimages/iStock/Getty Images)

Cost-plus pricing is a business pricing strategy that begins with a calculation of all costs involved in producing or acquiring a product. After your company determines the cost to market a good, it adds a certain percentage of markup to achieve profit objectives.

How Cost-Plus Works

Common cost categories for a company include direct materials costs, direct labor costs and overhead. While variable costs are those that directly affect the production or acquisition of a good, you must account for fixed overhead costs when setting prices. Therefore, you allocate a portion of overhead to each product made or acquired. Next, add on the determined markup for the good. Some companies have a standard markup for all goods. Others use different markups for different categories. If costs are $10 and you want a 40 percent markup, the price is $14.

Pros and Cons

Small-business owners use a cost-plus model because it is conservative and ensures your price points achieve a certain margin. The drawback is that, unlike market-driven strategies, a cost-plus approach gives no credence to what customers are willing to pay. Therefore, you can set a $14 price point, but goods may sit on a shelf until you have to discount them to clear space.

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